Balancing Trading and Issuer Protection in a Fragmented Market

I was at the World Federation of Exchanges annual conference in October, and Duncan Niederauer, the CEO of NYSE Euronext, spoke about the importance of markets, capital formation, IPOs and job creation. While the talk was interesting, what caught my imagination was the idea of the corporate issuer in relation to market structure.

My thought went something like this: To trade, companies need to be listed, and exchanges compete to offer listing services. Once listed, however, equities can be traded in any number of venues. But what happens when there is a market abnormality and the issuer's stock trades at a penny? What happens when this errant trade is executed outside the listing venue (especially when the listing venue was slowed or halted)?

What responsibility does the listing exchange have to the issuer when the company's stock is artificially worth zilch? When the issuer calls and screams, "Why did my stock trade at a penny?" is the exchange's only response to act like my kids did when they were young and say, "I didn't do it; it wasn't my fault!"

Does a problem like this undercut the value of a listing exchange, or does this make the listing exchange responsible for all of the challenges, ills and vagaries of the market -- even if the exchange has less than a 30 percent market share in the primary issue? Does this undercut the value of being publicly traded?

Last year Grant Thornton published a study blaming high-frequency trading for hurting capital formation. While that study attempted to refocus attention on the laudatory nature of rebuilding the capital value chain (capital, spreads, commissions, research and market making), I am not convinced that HFT hurts capital formation. But I do think an event like the May 6 Flash Crash does.

If markets are so fragmented that they do not function properly, and corporate equity cannot be effectively valued, then what value does a listing provide? Wouldn't corporations be safer being privately held? Wouldn't corporations have more continuity with fewer and more committed equity holders (a la private equity) rather than being subject to the vagaries of widely disparate shareholders in a nonfunctioning, dislocated market? And if issuers raise capital in our markets, then what is their value, except as a place for traders to profit on the discontinuities of a broken marketplace?

With Power Comes Responsibility

So how do we protect corporate issuers from a broken market? If broken markets are bad for issuers, shouldn't we put more pressure on the listing exchange to ensure safer markets, as there is an implicit -- if not explicit -- fiduciary agreement?

With that extra level of responsibility, however, there needs to be a level of control. Maybe we should limit the trading of products to their listed exchanges, or make secondary markets pay for the right to trade products they do not list. Maybe the secondary markets should be required to demonstrate a stable and efficient market structure and, if it can't, the issuer could pull the trading license for that product. If the listing market created the problem, then maybe the issuer should have the ability to more easily switch its listing to another venue.

Now that I have upset most of, if not the whole, trading community, I am not sure that we want to go back to monopolistic exchanges; my point, rather, is that while most of us focus on trading and trading efficiency, the real point of our markets is to raise capital. When we focus on trading above issuers, is the tail (asset pricing and transfer) wagging the dog (capital formation)?

I am not saying that trading is not important; it is. But we do need to bring back some level of parity, as it seems as if we have so completely focused on trading that we have almost completely forgotten about the issuer. Maybe this equation needs to be tipped back into balance.